Guest Post By Robert Ochieng
If there is something that I am sure about in the world of investing, it is that there is no panacea in managing risk.
In 2005, David Tweedie who was the chair of IASB at the time, famously said that
“Anyone who claims to understand IAS 39 hasn’t read it properly.”
Fast forward in 2008 during the financial crisis, even the staunch defenders of IAS39 found the standard irrelevant in the way it allowed banks to manage risk in hindsight.
Despite the fact that IAS39 was not responsible for the 2008 financial crisis, it did no help mitigate the risks that it had surprised to help manage.
The result of that has been the emergence of IFRS9 , the blameworthy accounting that is attempting to be the panacea of managing risk in banking. It attempts to put the responsibility of 2008 financial crisis to accounting yet we know too well that correlation doesn’t imply causation. We cant assume that accounting alone, done in silo by accountants then pushed down to banking sector, a very critical sector in world economies will be the ultimate solution for risk management.
IFRS9 is an ex-ante solution that promises to estimate future risk. Yes , future! But how good are human beings at forecasting? The biggest issue with IFRS9 is that it relies on modelling. Modelling is a key aspect in machine learning which attempts to provide solutions based on historical occurrences. Modelling uses different parameters in attempt to estimate future occurrences and one aspect of that is the use of what are called as hyper-parameters. These are the parameters in the model that requires human judgement making modelling and IFRS9 very subjective! That means that if were to look at ARM cement , cement sector, entry of Dangote cement into East African when modeling the risk of ARM Cement company, KCB, Equity etc would each have different results. As such there is a lot of reliance on the judgement of the analyst doing modelling hence we cant begin to sell IFRS9 as the ultimate solution.
That said, it is a step in the right direction and i feel it will be trapped in the quicksand of its own oversell because it promises the impossible at least on planet earth that is very abstract.
In conclusion, banking sector is very critical in economies and as such that the stability of the sector implicitly determine the longevity of the bureaucrats who will do anything to manage and prevent systemic risks in the banking sector. A good example is the rate cap debate in the Kenyan banking sector. As such I am still bullish on the selected quality banking stocks in the long term.
The writer is an investor at the Nairobi Securities Exchange with a keen focus on the banking sector stocks.